Taxes were already known to be a new issue for ISRG in 2006 and 2007, and they also gave conservative guidance to begin 2005 (and we all know how that worked out, with the shares roughly tripling last year), so I considered both of those to be non-critical issues in light of the long term prospects for this business.
So I put in a limit order for Intuitive Surgical (ISRG) at $112, just a few dollars higher than my last purchase at $109 in November. I was actually a little surprised that it dipped that low almost as the market opened and I received the shares, but I'm happy to have them. In the short term, it may well dip further below this point, but I expect to hold these for dramatic growth over many years.
I have written many times about Intuitive Surgical since I first bought shares -- most extensively when I looked at growth and the extent to which hospitals are advertising their robotic capabillities, and when I pondered the valuation and decided I thought it was reasonable.
Here's what I learned from the call :
They sold 40 systems in the fourth quarter, 9 of them overseas. 3 Da Vinci systems have been placed in training centers. There are now 394 systems worldwide, and 31 hospitals now have multiple systems. They expect 1500 hospitals to be their market, and 3 machines per hospital to be a reasonable target. 150 robots overall were sold in 2005.
Growth continued to be dramatic -- revenue was up 60%, high-margin recurring revenue was up more than 70% (and is now 45% of revenue). They generally realize between $1,500 and $2,000 per procedure in instruments sales, so the growth (expected perhaps to be 70,000 operations this year, double last year) should continue apace in the recurring revenues space.
They have a great balance sheet -- $203 million cash, even after they bought a new building from HP (which tripled space for manufacturing and operations; I consider that to be very optimistic).
Several new studies were released this year indicating continued improvements in cancer control, continence and sexual function for robotic prostatectomies -- 20% of prostatectomies are already performed with the da Vinci, and I think patient demand should continue to drive that much higher (their goal is hitting 25% this year, which I think is conservative). The only argument against da Vinci prostatectomies is now the high up front cost. It's definitely worth listening to the call (archived on their website) just for the clinical update.
My opinion on the cost issue: In most cases hospitals can't charge more for the robotic procedures than for open procedures, but in the future this might change with the clear benefits to insurers of much shorter hospital stays and better results.
Mitral valve repair, gastric bypass, and "da vinci hysterectomy" can all be significant drivers of procedure growth if the good results we've so far seen continue. The huge gynecological market is just beginning to be tapped and may show growth that compares to prostatectomies in the coming years (but for a much larger market). It took about two years of study before the prostate surgery took off for ISRG, so the gynecological growth may be a year or two from hitting its stride.
Definitely worth listening to the conference call if only for the detailed review of the medical studies and literature -- the momentum in both increasing depth and breadth of procedures should continue without moderation given the consistently excellent results.
Then there were the guidance issues, which were what brought the share price down to my buying level:
There is continued growth in demand. Total revenue growth of 25-30%. Instrument/accessory 45-55%, service 35-57%. Systems growth was lowballed at 15-25% given new system -- they're concerned that the ramp-up of the da Vinci S might delay some purchasing decisions as hospitals decide which machine to go with.
Gross margins should decrease near term due to low volume of Da Vinci S, then steadily increase by end of year to roughly current levels as the get volumes up.
Options expensing is going to be an issue for ISRG this year as well, again as expected. 2006 options expense should be between $21-28 million. Dilution could be as much as 10% or so depending on share price.
What everyone was talking about was the "tax event" that dramatically increased (almost doubled) 4Q earnings. Net taxes were negative in 2005, and guidance is impacted by the fact that they anticipate a 36-42% tax rate going forward that will impact reported earnings dramatically, but it is important to note that the majority of those taxes will not actually be paid in cash due to their remaining carryforwards that will get them through much of the year without any taxes due.
Robotic surgery continues to advance, and though it's always risky to be invested in a company with this kind of growth expectation I genuinely believe that they're underestimating the potential growth of robotic surgery ... and they remain the monopoly owner of the only meaningful and FDA approved surgical robot in the world. I would not be shocked if the price was cut dramatically at some point if their installations dip for a quarter or two, but I'm convinced that over the next five years this is going to be a spectacular investment.